Institutional Investors.
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Institutional investors encompass a broad category. Included in this group are hedge funds, pension plans, insurance companies, retirement funds and money mangers.
An organization that trades in such sufficient quantities that they are eligible for lower commissions and red carpet treatment are considered institutional. They face fewer regulations than the average investor because it is assumed the institutional investor is more knowledgeable.
Portfolio managers have access to stock analysts, computer models and real-time information. Most of us have Yahoo!, Jim Cramer and whatever service we subscribe to.
After an institutional investor takes a large position in a stock they have to make sure it goes up. One of the ways they do this, is promote it. It’s not unusual to see investment managers on TV or at conferences extolling the virtues of a wonderful company.
I have to say it works. When a top portfolio manager goes on CNBC claiming he owns stock in a company that has the patent to cure male baldness, you know that stock will be a percentage gainer by day’s end.
Money managers also use performance enhancing tools that mutual funds and average investors can’t. At their disposal are derivatives, futures and options. If the market is going their way, derivatives and options can really boost returns.
On the other side of this coin is pricing or “marking to market”. These calculations determine how well the portfolio is doing. While stock prices are public and easily attainable, certain derivatives are not.
When managers price these complex instruments the information they use is subjective. The source can be the value of similar instruments, data from a dealer-pricing service or even management’s best guess….errrr analytical judgment.
How does institutional buying affect you? 70% of all trade volume comes from institutional traders. They usually don’t dabble in low priced stocks. If you want to ride off their buying power stick to higher priced stocks and track accumulation.
If an institution decides to sell their holdings, the selling pressure can easily impact the individual investor. There you are, sitting happily with 600 shares of Ebay at $34 per share. Then along comes Big Swinging Hedge Fund and they decide to sell a couple million of their Ebay shares. Other funds may notice this and think something's up with Ebay. They may start selling their shares too. By the end of the day, Ebay won't be $34 anymore. But a lot less.
Why Institutional Investors Can’t Beat The Market
Maybe institutions can beat the market. I’m just relaying theories why they can’t. Don’t shoot the messenger.
• EMT: Efficient Market Theory. This states everything you ever want to know about a stock but were afraid to ask is already reflected in the price. This being the case, it would be hard to find undervalued stocks. Because most stocks would be priced "just right".
• Transaction Costs: It costs money to buy and sell large amounts of securities. If you’re a firm managing a large portfolio, you have high tranaction costs. These costs are deducted from the portfolio’s return
• Taxes: Taxes are a firm’s largest expense. This surpasses commission charges and management fees. If a money manager achieved a 12% return and all fees totaled between 3-4%, well you do the math. You end up with a return that matches a simple mutual fund.
• Follow The Herd : Investment firms tend to follow each other’s lead. When several investors go after the same stocks, volatility increases.
Because of taxes and transaction costs, money managers must be creative in their strategies to beat the market. If a firm beats the market for several years in a row, statistics says a reversion to the mean is due.
Mean reversion theory states that over time, prices and returns will return to the average rate. So even if a firm was getting slammed by the market, it's due for a little uptick.
Alpha is that portion of a portfolio’s return generated by the aptitude of the manager. This is how investment managers differentiate themselves from the pack. My alpha is bigger than your alpha.
If the S&P had 11% returns this year and an investment firm had 14%, then 3% of the return is considered alpha. Also known as the manager's skill. The alpha is important to money management firms. It says "Yes, I can beat the market. Any questions!"
Money management is a growth industry. The population is getting older and the rich are getting richer. Someone needs to manage the cash.
As banks strive to become one-stop-shops they offer investment services to attract and keep a wealthy client base.
For the time being, I’ll stick with mutual funds. But if Lotto goes my way on Friday, I'll be calling Goldman Sachs Wealth Management. Let them deal with it.
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